The purpose of this weekly is to sharpen my thinking by sharing thoughts about industries and companies that fit into powerful long-term investment themes. It is also a place to share insights into decision-making, takeaways from the past week, and random thoughts that arise. Thank you for reading this piece! Feedback is welcomed. 

This week: 

• Transformational Change and the Emotional Swings 
• How Big is the Pile? 

Transformational Change and the Emotional Swings 

“The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time and still retain the ability to function.” — F. Scott Fitzgerald 

Generative AI is getting a lot of attention in the press, at the corporate level, and from investors. We have been talking about it for some time and have posted here quite a few thoughts on our excitement as well as our views on ways to participate in growth. 

While we are still very early in the journey for Gen AI, a lot of investor excitement has been building, as have the stock returns for a handful of companies. It is hard to remember a prior period when one company’s earnings report garnered so much attention as the report from Nvidia this week. 

As we move toward increased AI adoption and see more use cases for Gen AI, there will be increased excitement, and it will spark a debate about whether there is too much hype and even invoke the question of whether we are in a bubble. This is a time-tested debate when there is transformational change. We anticipate the explosive growth in both revenue and profits that Nvidia has shown will bring in more anticipation. To prepare for this possibility, I thought revisiting the Internet Era and the learnings from that period would be a good idea. 

One of the important learnings from the Internet Era is that investors are pretty good at sniffing out something that will be transformational but may not be great at the timing. When Netscape first went public in 1995, there was a lot of

anticipation, and the IPO was a huge success. It opened the floodgates for other companies to go public and by the end of the decade, multiple companies were going public every day. 

Enthusiasm ran high for the better part of 1999 and 2000. This led to what turned out to be the dot com bubble. The run-up and the subsequent decline are well documented and certainly a good guide for what to watch for in other periods of transformational change. 

One thing that I recall from that period was the debate about “new economy” versus “old economy” companies and their stocks. The argument for new economy stocks was that we could not foresee the impact that having the internet would have, but that it was going to be very large. There were naysayers who pointed to business models that were not profitable and were not proven in any capacity. Plus, they said that there were new metrics being used to justify the lofty valuations of the dot com companies. 

The funny thing in retrospect is that investors on both sides of this debate were correct, just not in application and timing. Let me explain. 

The “new economy” camp was correct, the internet was transformational, as we all know. It has changed so many things that it doesn’t require a list. It has also added more dimensions to its impact as the years have gone by, making the early views of how it would change society and the economy look tiny in comparison. 

The “old economy” camp was correct, the internet companies did not have business models that were proven, and the valuations assigned to them made little sense at the time. 

This is where emotion comes in. There was a ton of fear when the melt-up was happening, lots of FOMO. My first board meeting for the mutual fund I was managing at that time was uncomfortable. One of my fellow Portfolio Managers was being grilled by the board for not having internet exposure in a fund with a capital appreciation mandate. He defended his view that internet companies had yet to show longer-term promise from a business model perspective. He was a bit cursed at the time for having tons of experience. He was replaced shortly after that, and if it wasn’t the top tick, it was close. The bottom line is that it was an emotionally charged period, to say the least. 

The new economy camp got it right on the direction and importance of the transformational change but got the timing wrong, or the investments wrong, at

least initially. The old economy group made the right call to not load up on these companies as the prices rose, and protected capital for investors. 

It took a few years, but in the aftermath of the dot com bust, the most consequential companies of our time were taking shape. Tremendous wealth and investment returns have been created by these companies that have essentially created the “new economy.” 

The hangover from the dot com bust kept many investors from wading into these companies, leaving a lot of opportunities on the table. This is true for those who chose to let the negative emotion of the price declines affect their view of the present and future. 

If you were in the old economy camp and never updated your views, you missed the last 10-15 years of well above-average returns for your investors by not owning these companies that participated in the growth and proliferation of the new economy. 

We will likely go through a few swings in emotion as Gen AI moves along the adoption curve. It feels like we are already getting a taste of it. The inevitable calls of “this is a bubble!” will emerge. So, how will we know if there is too much enthusiasm or positive emotion? Going back to the Internet Era, these were the signs then, and they could be good guideposts now: 

1. Enthusiasm was so universal that when a company announced a website or added .com to its name, its stock would rise significantly. 
2. Stocks were rising so rapidly that investors were creating new metrics to justify valuations, such as market value to eyeballs. No, that’s not a joke. I had one company use the term EBE. When I asked, they said it was earnings before expenses. 
3. Lots of public offerings. The bankers will not miss out on the opportunity. When they are busy, and supply rises, that’s not a good sign. 
4. A big VC raise cycle. 

So far, these are not present. The AI bellwether, Nvidia, has increased revenue and profits dramatically. The market loves profits and makes adjustments to the valuation accordingly. Wise reinvestment of increasing profits creates more value over time, which in turn, produces positive returns off the new higher level of the stock price. Just because a stock goes up does not mean it will go down. Maybe in

short spurts, but over longer periods, it has to do with the ability to layer on more revenue and profits. 

The bottom line is that the way that we are thinking about this is that Gen AI is a very important innovation and is a transformational change. It will enable some companies to grow to either become significant or more significant. The companies that are direct AI beneficiaries and perhaps the overall market will sometimes get overvalued as AI evolves. It does not mean that it will be a repeat of the dot com bubble. It could happen, but it is not inevitable by any means. It could be true that Gen AI is transformational, and it could generate a lot of emotion along the way. Our mindset is to be aware of some of the telltale signs of too much enthusiasm and act when they occur. But our overall view is on the horizon to always look for opportunities. That was the biggest takeaway for me in the Internet Era, which is that investors can spot an important new thing but could very well be early. That doesn’t mean that it isn’t a great long-term opportunity. 

So, in summary, to go back to the Fitzgerald quote, we can see that it can be confusing given the pace of change, and there can be seemingly competing forces as we move along the adoption curve. These things could all be true at the same time: 

• Gen AI is a transformative change. 
• The true long-term winners may not yet be obvious. 
• Some AI-related beneficiaries could be overvalued right now. • Some of those companies could totally deserve the hype and high valuations. 
• A short-term sell-off in the AI companies and/or the market does not change the fact that AI will be very important in the longer-term returns of many companies and the overall market. 
• Widespread bad behavior that is the cause of bubbles is not present now, despite huge market appreciation for AI bellwethers. 

As in the Internet Era, being “right” could be viewed differently depending on one’s timeframe. 

Note to readers: Arrowside Capital holds positions in Nvidia. 

How Big is the Pile?

A colleague, mentor, and friend of mine used to collect printed prospectuses of companies that were raising capital via IPOs. This was back in the 1990s. I was younger and didn’t have the context, but he asked the sell-side firms to make sure they mailed him all the offerings. He didn’t read them all, just the ones that were in his area of coverage.  

I once asked him why he wanted all the copies and why he kept them. He said, “When the pile gets large, I get worried.” When I probed further, he said “The bankers can’t help themselves; it’s the way they make money. At the end of the 

cycle, they pump out some of the worst companies that are nowhere ready to be public. This is always a bad sign for markets in the subsequent period.” 

Fortunately for me, I was in the office right next to his, and I saw the pile grow firsthand during the dot com period. I took his advice and avoided many of the IPO offerings at the time, many of which produced good one-day returns and terrible 30, 90, and 360+ day returns.  

In the aftermath of the dot com collapse, there was a long period of hangover that had to be worn off before trust and confidence were built back. A company that goes public too early at a high valuation is a very bad thing for any period other than the initial pop in the stock price. A more recent and very relevant example of this is the SPAC craze in 2021 and the companies that now are public but at a fraction of the valuation of the initial offering. It is unclear what will happen to this class of offerings, but there has been serious carnage.  

So, while there are no more physically printed prospectuses, the concept of “How big is the plie?” stays with me. It’s just human that when things are good, there is more activity, more offerings. Investors can get greedy or more short-term oriented in rection as the prices rise.  

But what we are left with are the underlying fundamentals of the businesses.  My story 

I am an investor and entrepreneur, having started two investment companies. I am the Founder and CIO of Arrowside Capital (http://www.arrowside.com), based in Boston, MA. I have more than 30 years of experience in the investment business, investing in companies geared toward innovation and growth. The blog is named The Zen Innovation Investor because I believe it is so important to remain calm

and focused during the rapid pace of change in the world today. I am keeping a view of the long term while also keeping abreast of developments in the world of innovative companies. I view this as a place to sharpen my thinking and provide some insights that are thought-provoking. 

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